Last week, Liz raised the topic of thematic investing so I thought this week I would follow up on this area and look at what is perhaps the hottest area of the market at the moment, Technology.
When it comes to investing we love an acronym as they often group together companies which tell a similar narrative or point to a particular theme.
The term FANG was first coined in the US in 2009 by Jim Cramer, host of the CNBC show Mad Money. FANG represents the most popular and best-performing tech stocks in the market that have generated spectacular returns for their investors. These four stocks are Facebook, Amazon, Netflix and Google. The acronym has more recently been widened to include Apple which at the beginning of August became the first listed company to exceed a $1 trillion valuation. So does the technology sector have further to go?
The returns investors have seen in these stocks have been impressive, driven by a combination of factors. First, and most importantly, is the growth of each of the businesses, which has far outstripped the growth of most other large businesses. The figures are impressive, Amazon recently passed 100m subscribers to its Prime service, while Netflix took on over 7 million new subscribers in the first quarter of this year alone. What makes this growth even more impressive is that it has been achieved in a world where economic growth has been subdued. These companies have been able to create their own growth and appear immune to the economic environment as they focus on their own businesses and not the wider economy, which is out of their control.
The use of technology has helped each of the FAANGs establish itself as a market leader in its field and put up significant barriers to entry, making it difficult to for other companies to compete. For example, if all your friends are on Facebook you are almost forced to use it if you want to join their social network.
The benefits of using technology effectively are huge. These companies can access millions of customers at a fraction of the cost and, having established themselves in one market, they are looking to spread into other areas such as driverless cars, healthcare or cloud computing services. Unlike their predecessors, these companies focus on data and use it to analyse the impact of everything they do, enabling them to offer a superior service.
However, investors should not look at all the FAANGs equally. Each company operates differently and has its own proposition. Risks are not shared equally; Facebook and google face potentially significant regulation, while Netflix is already in competition to Amazon and will soon be joined by Disney, both of which have very deep pockets. Apple is looking to replace revenues as demand for its core iPhone product has slowed but continues to demand a premium for its products. Beyond the FAANGs there are other high-profile companies such as Tesla, which have attracted almost fanatical investor support, albeit with some vocal sceptics as well.
It is not just the risks of the giant tech stocks that are different - valuations vary significantly as well. Tesla, with its ardent fan base, has a market cap of $51bn but does not make a profit and as such has no P/E ratio. Apple on the other hand generates over $50bn of revenue a quarter and has a P/E ratio of around 17 - that is below the average of 22 for the NASDAQ and not excessive for a Tech company that posted double digit earnings growth for the fourth quarter in a row.
Investing in technology is about stock-picking and diversification. It is easy to understand the excitement that surrounds companies which have the technology to disrupt established players and revolutionize the world. But do not get caught up in the excitement. Markets are extrapolating today’s growth of the tech giants far into the future and attaching high valuations on some of these stocks, effectively pricing them for perfection. While some of these stocks may achieve the expected growth, investors are paying for it today and to get a decent return on the investment either the companies will need to beat expectations or the market will need to raise expectations for even more growth. This is why the return you get on your investment is influenced by the price you pay for it.
While the valuations of some stocks have gotten ahead of themselves, it is clear the technology theme is here to stay and arguably we are at the foothills of a technological revolution. This will create plenty of opportunities, not just in technology companies but in companies which provide support services, the picks and shovels if you like, and in businesses that are best able to utilise technology to make themselves competitive.
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